Outsourcing your startup’s early technical development to a dev shop is like riding an elephant in a horseback polo match. You’re on a big beast, but your lack of agility will prevent you from scoring.
With the surge in demand for technical co-founders, many startups have no choice but to contract with dev shops to build their idea. Most of these early “partnerships” never work, regardless of how the startup compensates the dev shop.
Even if a startup compensates the dev shop with equity or cash + equity, the amount of equity will not likely be enough to get the dev shop to devote the time, effort, and TLC that a true technical co-founder would. A dev shop is never a substitute for a technical co-founder.
Around the time the dev shop delivers the product (if the dev shop delivers the product), the startup usually figures out their product is actually their prototype as the startup now desires additional features. Alternatively, the startup mistakenly believes that the dev shop will deliver a turn-key product that will not require additional development through the customer development process.
Either way, the startup will require additional technical development, but may lack the resources to continue compensating the dev shop.
In conclusion, if your startup chooses to ride the elephant, it must realize that the dev shop is only a short-term solution. Therefore, be sure that equity compensation in exchange for dev shop services is “small” and vests according to a milestone schedule.
Just to be clear, my intent in writing this article is not to be critical of dev shops or the startups that seek their services. Incentives are difficult to align completely, and the startup-dev shop partnership is an ultra-difficult case.